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A Star for China’s
Energy Transition
Five Golden Rules for an Efficient
­Transformation of China’s Energy System
IMPULSE
A Star for China’s
Energy Transition
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IMPULSE
ACKNOWLEDGEMENTS
A Star for China’s Energy Transition
We acknowledge GIZ (Deutsche Gesellschaft für
Internationale Zusammenarbeit (GIZ) GmbH) for
its financial support and advice during the whole
process.
Five Golden Rules for an Efficient
Transformation of China’s Energy System
STUDY BY:
Agora Energiewende
Anna-Louisa-Karsch-Straße 2
10178 Berlin | Germany
China National Renewable Energy Center
(CNREC)
AUTHORS:
Shuwei Zhang
shuwei.zhang@agora-energiewende.de
Yongqiang Zhao
zhaoyongqiang@cnrec.org.cn
Special thanks for reviewing this report go to:
Wang Zhongying,
CNREC & Energy Research Institute (ERI)
Anders Hove,
GIZ China
Agora Energiewende is a joint initiative of
the Mercator Foundation and the European
Climate Foundation. The cooperation of Agora
Energiewende and the China National Renewable
Energy Centre in China is kindly supported by
the Deutsche Gesellschaft für Internationale
Zusammenarbeit (GIZ) on behalf
of the German government.
Markus Steigenberger
markus.steigenberger@agora-energiewende.de
WITH CONTRIBUTIONS FROM:
Mara Marthe Kleiner
Thomas Kouroughli
Christian Redl
Proofreading: WordSolid, Berlin
Layout: UKEX GRAPHIC Urs Karcher
Cover image: unsplash.com/alexandre valdivia
144/06-I-2018/EN
Publication: October 2018
This publication is available for
download under this QR code.
Please cite as:
Agora Energiewende (2018): A Star for China’s
Energy Transition: Five Golden Rules for an Efficient Transformation of China’s Energy System.
www.agora-energiewende.de
Preface
Dear readers,
China has become one of the world’s leading countries in the fight against climate change. It has taken
a proactive stance in UN climate negotiations and
now leads the world in renewable energy deployment.
At the same time, China continues to struggle with
its own air pollution and greenhouse gas emissions.
While Chinese emissions declined in past years, they
began to rise again in 2017.
One of China’s largest clean-energy projects is the trans­
formation of its power sector. The government aims to
increase the share of non fossil-fuel based electricity in
its power system to 50 per cent by 2030. According to
our calculations (and those of others), this target is ambitious but feasible. Despite the achievements of recent
years, significant challenges remain, especially with
regard to the re-structuring of the power system.
This report addresses some of these challenges in
detail. It builds on the lessons (positive as well as
negative) that we have learned in Europe in recent
decades. The key insight offered by the report is that
a holistic perspective is necessary to ensure compatibility between policy instruments. We have summarized our findings in Five Golden Rules.
I hope you find this report stimulating, and that it
helps to catalyse the policy changes necessary for a
successful clean-energy transition in China.
Sincerely,
Dr Patrick Graichen
Executive Director of Agora Energiewende
Key findings at a glance:
1
To achieve a 50 per cent share of clean electricity by 2030 at a minimum cost, China needs to add around 35 GW
of wind energy and 65 GW of solar energy per year between 2020 and 2030. This would be roughly in line with the
quickest deployment levels seen in previous years. With a rapid decline in technology costs, wind and solar can
serve as a substitute for new nuclear and hydro, which current plans foresee growing at an unrealistically high rate.
2
“Flexibility” will need to become the new watchword in China’s power system, as by 2030 roughly 25 per cent of the
power supply comes from variable renewables. Restructuring the power system will be essential in order to keep
it reliable and cost-effective. Inflexible baseload technologies and non-merit-order-based, coarse-scale dispatch are
­incompatible with a system that is increasingly dominated by weather-dependent power generation technologies.
3
China has initiated a number of important reforms already, but fundamental challenges still lie ahead.
Recent policy reforms have moved in the right direction, as China has started pilot projects for emissions trading,
has reviewed its renewables remuneration scheme, and has acknowledged the need to create a power spot
market. However, fundamental challenges remain to be addressed. These include overcapacity in coal-fired a
­ ssets,
an inflexible dispatch system, and a lack of data transparency and accessibility for market participants.
4
Five Golden Rules will help build a consistent policy regime and guarantee system reliability and cost-effectiveness. China has the opportunity to leapfrog to a renewables-led power system design that ensures cost-effectiveness and reliability. The Five Golden Rules we develop in this paper will help policy makers view the various
policy instruments and emerging sectoral markets both pragmatically and coherently while taking into account
interdependencies and avoiding inconsistencies:
Golden Rule 1: Use existing generation capacity efficiently by implementing short-term markets
Golden Rule 2: Incentivise flexibility to ensure system reliability and adequacy
Golden Rule 3: Provide stable revenues for new investment in renewables
Golden Rule 4: Manage the decline of coal and its structural consequences
Golden Rule 5: Acknowledge the pivotal role of transparency and data accessibility
3
Agora Energiewende | A Star for China’s Energy Transition
4
Content
Introduction
7
Background: Shedding Light on China’s Climate and Energy Targets
9
1
Renewables-led Energy Transitions: Perfect Theory and Imperfect Practice
1.1
Simplified Perfect Theory of EOM and ETS
1.2 Shortcomings of Real World EOM and ETS
1.3 Additional Complexity in the Chinese System
15
15
18
21
2
Five Golden Rules for the Chinese Power Market Transition
Golden Rule 1 | Use Existing Generation Capacity Efficiently
By Implementing Short-Term Markets
Golden Rule 2 | Incentivise Flexibility to Ensure System Reliability and Adequacy
Golden Rule 3 | Provide Stable Revenues for New Investments in Renewables
Golden Rule 4 | Manage the Decline of Coal and Its Structural Consequences
Golden Rule 5 | A
cknowledge the Pivotal Role of Transparency and
Data Accessibility
25
26
28
28
30
33
Conclusions
35
References
37
5
Agora Energiewende | A Star for China’s Energy Transition
6
IMPULSE | A Star for China’s Energy Transition
Introduction
Wind and solar energy have grown at a strong pace
in recent years in China, and now it faces new challenges through the transition to clean energy. It is no
longer enough to simply build additional capacity.
China also needs to view the various elements of its
energy system from a holistic perspective.
This sounds like an obvious statement, but adopting
an integrated perspective is difficult, as experiences
in Germany and elsewhere have shown. Consider for
a moment the various policy instruments that have
been enacted in Germany over the years, without
giving serious thought to their mutual interaction.
There might have been good reasons for each decision, but the overall outcome has been inefficient.
To give just one example: despite the rapid growth of
renewable energy in recent years, Germany’s greenhouse gas emissions have not decreased. Inconsistent policy measures are the cause: specifically, the
failure of the European emissions trading scheme and
the lack of additional instruments to reduce carbon
intensive energy production.
The challenges arising in China are similar to those
encountered in Germany and Europe. We met with
our Chinese partner CNREC and discussed how the
Chinese power system can be transformed in an integrated manner. Obviously, many Chinese particularities need to be taken into account. But the need to
consider different policy instruments in a coherent
and integrated manner remains the same.
This report is the result of these discussions. It provides a high-level perspective on how different policy instruments and markets interact and can contribute to a more efficient and reliable future energy
system in China. In doing so, we argue for a pragmatic
perspective that does not stick to textbook economic
theory but rather acknowledges real-world experience. This analysis intends to focus the debate on key
questions and implications that policy makers need
to keep in mind when designing future markets and
regulations.
Accordingly, for some years we have been arguing
that a pan-European perspective is essential. Clearly,
we need a coherent set of policies on renewable
energy funding, market design, and the reduction of
high-carbon assets.1
Interestingly, both China and Europe deploy a similar
mix of policy instruments, including:
→→ renewable remuneration schemes (voluntary and
obligatory instruments),
→→ carbon markets, especially the emissions trading
pilot programmes, and
→→ a tailored power market design, which is still under
development in China.
1
Agora Energiewende (2016a).
7
Agora Energiewende | A Star for China’s Energy Transition
8
IMPULSE | A Star for China’s Energy Transition
Background: Shedding Light on China’s Climate
and Energy Targets
At the Paris Climate Conference in December 2015,
China joined other nations in endorsing a global,
legally-binding target for keeping global warming
“well below 2 °C above pre-industrial levels” as well as
for “efforts to limit the temperature increase to 1.5 °C
above pre-industrial levels.”2
Meeting the Paris agreement will require, among
other things, that the global power sector be fully
decarbonised by no later than 2050.3 The power sector must necessarily lead decarbonisation efforts
because we already have cost-effective technologies for making this sector carbon free. This stands in
sharp contrast to other sectors, like agriculture and
industry, where technological developments are not
equally advanced and where emissions cuts cannot occur as rapidly. To achieve full decarbonisation of the power sector by 2050, about 50 per cent
of the process would need to be completed by 2030.
This intermediate goal requires large investments in
zero-carbon technologies within the next 15 years
to replace fossil-fuel assets and enable steep cuts in
short-term emissions. This demands the collective
effort of all countries – rich and poor – to realise a
fundamental transformation of power sectors around
the globe.
Given the size and emissions-intensity of ­China’s
power sector, and the need for swift action by 2030,
China needs to undertake significant domestic
efforts, independent of any global emissions trading
or regulation regimes that could emerge from international climate negotiations in coming years.
In its Nationally Determined Contribution (NDC),
China pledged to:
2
See Paris Agreement, Article 2.1 a).
3
IPCC (2018). Publication forthcoming.
→→ peak carbon dioxide emissions by around 2030
and make the best efforts to peak earlier;
→→ lower carbon dioxide emissions per unit of GDP by
60 to 65 per cent relative to 2005 levels;
→→ increase the share of non-fossil energy sources
(renewable and nuclear) in the energy mix to
around 20 per cent by 2030; and
→→ increase forest stock volume by around 4.5 billion
cubic meters relative to 2005 levels.
Since issuing its NDC, China has made substantial progress in adopting and implementing new
energy and environment policies. Coal consumption has remained relatively flat since 2013; in 2017,
the government accelerated the phase-out of direct
coal heating in the residential sector. Wind and solar
energy deployment in China continue to lead the
world in terms of both capacity and output. In 2017
alone, China added 53 GW of solar PV, almost five
times as much as was added in the United States.
Furthermore, this annual increase is larger than the
43 GW of total solar PV capacity in Germany.4 While
wind and solar curtailment remain high, both saw
improvement in 2017 and early 2018.5 The government has set a timeline to keep wind and solar curtailment below 5 per cent in all provinces by 2020,
and has implemented a number of measures for
ensuring this, including provincial renewable obligations, new power lines, and a monitoring system to
limit new investment in regions with high curtailment.
4
In June 2018, however, the Chinese government decided to
freeze new subsidy-based PV installations and allow for
around 20 GW of new capacity for this year.
5
NEA (2018a). It should be noted that the way to calculate
the curtailment rate might differ from country to country.
In China, this is indexed to the theoretical generation
potential of the renewable resource.
9
Agora Energiewende | A Star for China’s Energy Transition
Additional impetus for a cleaner energy system has
been triggered by public awareness of air pollution
and its implications for public health and the environment. In 2018, China revised its national constitution, making the development of an “ecological
civilization” and the protection of the environment a
key national goal.6 After President Xi Jinping’s 2014
speech calling for a revolution in energy production
and consumption, the government published its 2016
Energy Production and Consumption Revolution
Strategy (2016–2030). The strategy calls for China
to raise the share of non-fossil fuel power generation in total power generation to 50 per cent by 2030,
versus around 28 per cent in 2016. This is a clear
step beyond the NDC target of 20 per cent non-fossil
energy by 2030.
The Chinese government understands that a transition to cleaner energy, including the electrification
of transportation and industry, would help China to
tackle its air pollution challenges and put the country’s future growth on a less carbon-intensive pathway. It is clear that end-of-pipe emissions controls
can achieve at best only half of the emissions reductions needed for China to cut urban ambient PM2.5
concentrations to 30 micrograms per cubic metre
(µg/m3 ) by 2030, which is the national target.7
Changes on the structure of China’s energy system
are thus needed to meet air quality goals.
All of this has led to a fundamental debate about the
transformation of the energy system in China. In
some countries with functioning power markets and
integrated transmission systems, wind and solar have
replaced coal-fired electricity, often leading to early
plant retirements. The falling cost and improved efficiency of wind and solar make this vision increasingly practical for both local and national policy
makers.8 Costs for wind and solar power have fallen
to the extent that they have become cost-competitive
with other forms of energy generation in many places
around the world,9 although in China relative costs for
coal continue to be perceived as less expensive than
other options in the short term. In the most likely
scenario, which reflects the expectations of government and major industries, China’s goal of generating
at least 20 per cent of its energy from non-fossil fuel
by 2030 translates into a 38 per cent share of clean
electricity in the power sector.10 According to official plans, hydro and to a lesser degree nuclear power
would be the major contributors due to their planned
new installations and large-volume legacy capacity.
The share of wind and solar generation – known as
variable renewables (vRES) – in the total electricity generation mix are projected to increase from
around 7 per cent in 2017 to 10 per cent by 2020 and
to 15 per cent by 2030 (Figure 1). At this rate, China
would meet its 20 per cent non-fossil fuel target with
an average 5.3 per cent growth rate of GDP from 2015
to 2030 (Table 1). The carbon intensity reduction of
the economy would exceed 65 per cent relative to
2005, which corresponds to the high-end target in
the Climate NDC.
The 2030 non-fossil energy target of
20 per cent can be achieved with a
15 per cent share of wind and solar
­electricity generation
In this scenario, which is broadly consistent with
the government’s plan, wind capacity needs to grow
by 19 GW and solar PV by 26 GW annually between
2020 and 2030. As recent deployment rates have
exceeded these numbers (Table 2), meeting and eventually overshooting the 2030 NDC target should be
achievable.
6
Xinhua Agency (2018).
7
Ma Jun (2017).
9
8
Wang Zhongying (2018).
10 Zhang and Bauer (2014)
10
Agora Energiewende (2017a); IRENA (2018)
Fiscal depreciation term
Debt interest rate
Other site investment cost
Equity share fixed
Tax rate
Land lease
Business and technical management
Planning cost
Grid connection cost
Foundation
Direct marketing cost
Reserves
Insurance
Debt term
Equity term
Wind Resource/FLH
IMPULSE | A Star for China’s Energy Transition
RES generation out of total electricity, aligning with climate NDC and domestic targets
Figure 1
50%
50
Historical
45
Non-fossil fuel share
40
38%
Wind & solar in total electricity
33%
30
[%]
Non-fossil fuel in total electricity
34%
35
China NDC 2030 Projection
25
21%
20%
20
15%
15
Non-fossil fuel share
Non-fossil fuel share out of total electricity
15%
Wind and solar share of total electricity
10%
10
China‘s energy
revolution 2030 Projection
8%
5
Non-fossil fuel in total electricity
0
2000
2010
2020
Wind and solar share of total electricity
2030
Data (2000–2017) from annual flash reports of China Electric Council (CEC) and China’s official document Energy Revolution 2030. The projection period (2017–2030) represents the scenario for meeting the non-fossil fuel target (pink arrow) in China’s NDC. It considers the most likely
development pace of renewables, especially hydro and nuclear, whose lead time is over 5 years. Details can be found in Zhang and Bauer
(2013) and Wang and Zhang (2017).
Key economy and energy settings for the scenarios
GDP (2005 price, 100 million yuan)
Electricity demand (TWh)
Total energy consumption (10000 tce)
Non-fossil electricity share with targets
­according to NDC
Table 1
2005
2010
2015
2020
185896
317682
463889
635568
1009477
2494
4194
5802
6830
8770
261369
360648
429905
526347
555500
18%
20%
26%
34%
38%
10%
15%
10%
21%
10%
25%
Wind & solar share with targets according to
NDC
Wind & solar share with targets according to
50% domestic target
0%
Wind & solar share with targets f­ acing
­slowing-down hydro & nuclear
1%
4%
2030 projection
Note: Adapted and further analysis based on Zhang and Bauer (2014)
11
Agora Energiewende | A Star for China’s Energy Transition
Historic non-fossil fuel power generation capacities and projections
for 2020 and 2030
2016 (GW)
Hydro
Table 2
2017 (GW)
2020* (GW)
2030 (GW)
332
341
350
420–450
33
36
58
80–120
148
164
220
400-600
78
130
200
450–850
Solar Heating
–
–
10
~30
Biomass
12
12
15
15–100
Nuclear
Wind
Solar PV
* Various government plans and industrial projections (2020–2030); estimates from the government-affiliated think tanks the Electric Power
Planning & Engineering Institute (EPPEI) and the Renewable Energy Engineering Institute (CREEI); and personal communication with China
National Renewable Energy Center (CNREC).
Note: Biomass utilization in China is persistently limited and lag behind other countries. The upper end of hydro and nuclear corresponds to
Chinese government plans. In our view, hydro and nuclear are likely to halt completely after 2020 for projects that have yet to start.
The Chinese government therefore decided to pursue
a more ambitious path. The official Energy Production and Consumption Revolution Strategy (2016–
2030) aims at 50 per cent non-fossil electricity in
2030. This new target significantly outpaces the
NDC, and it indicates an accelerated development of
renewable energy.
The 50 per cent non-fossil fuel electricity target
translates into a 21 per cent share of wind and solar if
nuclear and hydro increase according to official plans
(the high-end of the numbers in Table 1), curtailment
rates of wind and solar PV can be reduced and the
energy intensity of the Chinese economy decreases.
Wind and solar PV curtailment (2011–2017)
Figure 2
100
20
[ TWh ]
60
40
20
49.7
11%
8%
16.2
33.9
16
12%
41.9
12
10%
8
13.3
2014
2015
2016
2017
2.5
4.8
7.4
7.3
2014
2015
2016
2017
4
0
Wind curtailment [ TWh ]
PV curtailment [ TWh ]
Wind curtailment rate
PV curtailment rate
NEA of China; quoted in GIZ (2018)
12
11%
6%
0
2013
9%
[%]
15%
80
17%
IMPULSE | A Star for China’s Energy Transition
But what happens if some of the government’s key
assumptions do not hold true? Specifically, what if:
make it increasingly unrealistic that China will meet
its 120 GW target.
→→ hydro and nuclear do not live up to expectations,
and growth slows down, or
→→ curtailment of wind and solar continues to occur at
current levels, or
→→ efficiency efforts remain insufficient and the
economy stays as energy-intensive as before?
Curtailment is another severe problem in China
­(Figure 2), especially in non-coastal areas, which
curtail up to 50 per cent of wind (without compensation). Comparisons with the US illustrate this point.
Although China’s installed wind capacity was greater
than that of the US in 2015 (145 versus 75 GW), it
generated less electricity (186 versus 191 TWh).11
In 2017, China had almost two times more installed
capacity than the US (164 versus 89 GW), but it surpassed US production by a much smaller margin (306
versus 254 TWh), which represents a gap of 50 per
cent in terms of utilization.12
According to previous expectations, hydro and
nuclear power capacity increase to 420 GW and
120 GW, respectively, by 2030, up from around
340 GW and 36 GW as of 2017.
But the pace of hydro and nuclear power development in China has been slowing down due to declining economic feasibility and many other hurdles.
For hydro, this includes the low market value of new
power assets in geographically remote regions, and
the problems associated with ecological damage and
migration. As for nuclear, rising costs due to more
stringent safety requirements and public resistance
Energy intensity is another concern. The NDC scenario assumes a limited growth of energy use from
2020 to 2030 due to efficiency measures. But if
energy elasticity continues to hover around 0.5, as it
11 Lu, et al. (2016).
12 Huenteler et al. (2018).
Power production from wind and solar [ TWh ]
2020–2030 wind and solar generation for robust targets in the face of multiple uncertainties
4,000
3,500
+19% p.a.
3,000
Figure 3
Additional generation necessary in
case of unimproved curtailment
(10% fewer operating hours)
2,500
Additional generation necessary in
case of an expected slow-down of
hydro and nuclear capacity additions
2,000
Additional generation necessary for
the 50% non-fossil fuel target
1,500
1,000
+8% p.a.
on average
+40% p.a.
2020 target according to
13th Five-Year-Plan
500
0
2010–2017
Historic
Generation necessary for
meeting NDC target
2020
Official
2030
Scenarios
Historic generation from
wind and solar
For historic data, CEC data and projection is scenario-based sensitivity analysis.
In the 2030 scenarios, the utilization rate of wind and solar is assumed to be 2,000 hours and 1,200 hours as the benchmark.
13
Agora Energiewende | A Star for China’s Energy Transition
has for the past 30 years, total energy use would rise
significantly. Under such a case, the efforts to expand
non fossil-fuel based electricity, especially that from
wind and solar, need to increase to offset the larger
energy use.
Each of these issues could have an impact on the
required installation rates for renewable energy – all
the more so, if they come to bear on China’s power
system all at once.
In a more dramatic scenario where the growth of
added hydro and nuclear capacity slows fundamentally, wind and solar growth would need to be more
than double the rate indicated in the benchmark case
(Figure 3). In such a case, reaching the 50 per cent non
fossil-fuel based electricity target would require an
annual installation of wind and solar PV beyond 35
GW and 65 GW between 2020 and 2030.
Clearly, wind and solar are cheap enough and have
proven their ability to grow rapidly. Among all variables, they are the most reliable and predictable. To
be on the safe side, it would be advisable to increase
the share of wind and solar in order to compensate for
a potential failure to deliver in other areas (i.e. lower
hydro or nuclear capacity expansion or higher than
expected energy demand). We estimate that a share of
wind and solar of around 25 per cent of total electricity generation by 2030 would ensure robust achievement of local and global pledges, despite remaining
uncertainties.
14
IMPULSE | A Star for China’s Energy Transition
1.
Renewables-led Energy Transitions:
Perfect Theory and Imperfect Practice
In Europe, proponents of a harmonised approach to
EU climate and energy policy have argued that the
European energy transition should be based on two
major elements: a strengthened Energy-Only Market (EOM) 13 and a strengthened EU Emissions Trading
scheme (ETS). It is claimed that these two instruments
offer the most cost-effective route for reliably transitioning to a low-carbon energy system, and that
additional instruments should be avoided or phased
out because they distort the effective functioning of
the EOM and ETS markets.
In North America, the situation is similar and some
economists support the idea of a carbon tax to decarbonise the energy system. According to a recent
survey by New York University,14 81 per cent of
economists consider a market-based system – a
combination of carbon pricing plus workable power
markets – to be most efficient, while 13 per cent
prefer performance standards and other regulated
programmes that prioritise cleaner fuels and energy
efficiency.
What about China? China has no experience with
short-term power markets,15 and it is only starting
to experiment with emissions trading schemes. But
China is talking about how to best design markets and
regulations in order to facilitate the energy transition cost-effectively. Like Europe and the US, viewpoints vary significantly. Some scholars praise the
spot market as an all-powerful instrument; others
13 See a detailed explanation on this terminology at
www.europarl.europa.eu/RegData/etudes/BRIE/.../EPRS_
BRI(2017)603949_EN.pdf
tend to prioritise long-term bilateral trading. Some
have placed great hopes in the emerging emissions
trading scheme; others point to the inherent mistakes
that would lead to the failure of the instrument and
explore alternatives such as supply-side polices for
renewable energy and coal.16
In this section we first discuss the theoretical underpinnings of such views. Later we argue why pure
textbook economics only partially hold true in the
real world 17, and China’s context only complicates the
matter. A holistic approach is especially needed when
it comes to renewable integration, stimulating new
investment, a working power market, and a reliable power system to enable a smooth transition to a
renewables-based power system.
1.1 Simplified Perfect Theory of EOM
and ETS
There has been of wealth of studies on the workings
of energy-only based power markets (EOM) and the
proper design of emission trading schemes. In theory,
the two instruments are a perfect match. The EOM
brings about scarcity prices that allow market participants to recover the capital costs of generation assets
and to ensure long-term system adequacy. An emissions trading scheme disproportionally increases
the cost of carbon-intensive generation technologies, which results in a competitive advantage for
low-carbon assets and hence an internalization of
external (environmental) costs.
14 Howard and Derek (2015).
16 See, for instance, Jaccord (2017) and Mendelevitch (2017).
15 In China, “spot market” is often used to refer to the wholesale market from day-ahead to real time. This may vary
from market design in North America and Europe.
17 These views assume perfect foresight, price-elastic demand, perfect competition and the complete internalization
of the external costs of carbon emissions.
15
Agora Energiewende | A Star for China’s Energy Transition
In the real world, however, inadequate policies can
distort the system and disrupt the theory.18 Thus far,
the combination of deregulated power sectors and
carbon pricing, i.e. EOM plus ETS, has neither delivered effective carbon reductions nor stimulated
investment in a diversified, zero-carbon power system of the future. To understand the reasons for this,
we must first lay out the assumptions of the underlying theory.
Claim 1: If left undistorted, energy-only markets
provide sufficient revenues and incentives for new
investment in all types of power generation and demand-response technologies
The assumption that EOMs provide sufficient revenues for new investments only holds true under
18 Agora Energiewende (2016a).
certain conditions. First, the demand side has to be
price-elastic, i.e. power consumers must reduce
their consumption when prices on the power market increase. A price-elastic demand curve facilitates market clearing (the process of matching supply and demand) when supply is saturated, leading
to so-called scarcity prices (Figure 4). Consumers
unwilling to pay the market clearing price reduce
electricity consumption during these hours, which
avoids involuntary load shedding (brownouts, rolling
blackouts). Prices during these hours reach high levels, thus facilitating total cost recovery for all technologies. In addition to price-elastic demand, the
conditions of perfect foresight and perfect competition must be met if an EOM is to deliver efficient
outcomes.19 If these conditions are met, boom & bust
cycles (repeated periods of over- and underinvestment) can be avoided.
19 De Vries (2013).
Figure 4
Price
Scarcity pricing in theoretical EOM environments facilitates cost recovery for all power plants
pScarcity
Supply
Demand
Quantity
Agora Energiewende (2016a)
16
IMPULSE | A Star for China’s Energy Transition
In the theoretical case, investment in so-called peaking plants is critical. This is because such plants
operate only for a few hours each day, at times when
consumption is high and renewables production is
low. Peaking plants require high scarcity prices during these operating hours to enable total cost recovery (including the initial investment).20
Power systems with high shares of wind and solar
energy pose an additional challenge because wind
and solar PV have relatively high investment costs
and very low operational costs. Known as zero-marginal-cost technologies, they are typically in operation when wholesale power prices are low, and benefit only infrequently from high prices. As a result,
20 It should be noted that in this case such plants may be able
to strongly manipulate the market. Accordingly, EOM always has a market force problem. For more, see Cramton &
Ockenfels (2012).
they are more vulnerable than conventional capacity
to stochastic scarcity prices.
In theory, undistorted power markets should ensure
total cost recovery for renewable technologies, for
low-carbon residual load-serving technologies and
for demand-side adaptations, provided that the ETS
sets a sufficiently high price on carbon emissions to
reflect the needed emission cuts.
Claim 2: Emissions trading schemes can incentivise
a cost-effective decarbonisation of the power system
by setting a binding and declining cap on emissions.
The EOM is agnostic about whether to use high- or
low-carbon technologies. But when combined with
an ETS, it is designed to steer investment to low- and
zero-carbon options, provided the previously exter-
Price
A binding cap on emissions triggers emission abatement measures. The cost of the
“marginal abatement” required to meet the cap sets the ETS certificate price.
Figure 5
Cap on GHG emissions
Ab
ate
me
nt
co
st
cu
rve
pCertificate
Emissions level prior to ETS
Emissions
Agora Energiewende (2016a)
17
Agora Energiewende | A Star for China’s Energy Transition
nalised costs of carbon emissions are internalised.21
The amount of this extra cost reflects the “socially
responsible” level of carbon emissions that may be
emitted by economic sectors that fall under the emissions trading scheme. Ideally, this cap is consistent
with long-term emission reductions required to meet
long-term climate change targets.
The emissions cap triggers a shortage of emission
allowances, which sets the price for emission certificates and incentivises abatement measures (Figure
5). The certificate price pushes the market to favour
low-carbon over high-carbon technologies and, theoretically, facilitates a cost-efficient reduction of CO₂
emissions, since investments occurs where marginal
abatement costs for reducing a given amount of emissions are the lowest.
The certificate price steers the dispatch of existing
resources, favouring the increased use of low-carbon plants while incentivising investment in new
low-carbon technologies as well as the closure of
high-carbon assets. At the same time, it can reduce
demand by passing on the carbon cost through the
electricity price. In effect, the ETS should enable
fuel-switching from high-carbon to low-carbon
assets and from carbon assets to carbon-free renewables for a more efficient achievement of emission
targets.
Like the EOM, the theoretical ETS case relies on certainty for market actors. They must have confidence
in the stability of the regulatory framework and in
the progressive and reliable reduction of the emissions cap over a period lasting several years to several
decades.
21 This pricing can result from an emissions trading scheme
or a carbon tax. In the following, we refer solely to ETS. For
the sake of simplicity, we have assumed a uniform carbon
price for all sectors.
18
1.2 Shortcomings of Real World EOM
and ETS
In our view, relying on solutions derived from simple
textbook economics would almost certainly cause
decarbonisation efforts to fall short, not only in China,
but all over the world. There are at least four reasons
why:
→→ ETS allowance prices high enough to incentivise
investment in zero-carbon technologies are unrealistic and would be unacceptable to many stakeholders.
→→ Uncertainties and risks hinder the right types of
future investments.
→→ Regulatory risk: Politicians do not want to take responsibility for the risk of outages by implementing safety nets
→→ Costs of renewables: The market value of renewable energy tends to decline as the share of renewable power in the mix rises (cannibalisation effect).22
Below we look at these four elements in more detail.
ETS allowance prices high enough to incentivise investment in zero-carbon technologies are unrealistic
and would be unacceptable to many stakeholders
For many observers, the political negotiations surrounding the European ETS during the past 20 years
have been sobering to follow. While everyone seems
to like the theoretical purity of the instrument, reallife practice has presented a very different picture.
Politicians have shied away from setting strong
emission caps, fearing abrupt changes and the impact
on European industry. From the beginning, the generous allocation of emission allowances and various
loopholes have paralysed the instrument and led to
negligible price levels.
22 Hirth (2016).
IMPULSE | A Star for China’s Energy Transition
Experience in North America (e.g. RGGI) and South
Korea has not been much different from that in
Europe or in China’s pilot projects. Frustrated with
this political failure in many places, decision-makers have given up on an “ETS only” solution and have
introduced additional instruments such as the minimum carbon price levels employed in California, Quebec/Canada and others.23
In Europe, most recent reforms seem to have had an
effect on the price. In September 2018, the EU ETS
price reached a 10-year high at about 25 EUR per ton.
This is still far from the socially optimal level, which
lies in the range of 60 to 80 EUR in short term and
higher afterward. It remains to be seen whether this
development will endure in the long term.
Uncertainty and risks hinder the right types of future
investments
EOM- and ETS-driven investment neglects one
important characteristic of real-life markets: uncertainty. A degree of uncertainty is a given in any market. Depending on its nature, uncertainty can be a
hindrance in markets that are supposed to help meet
political targets – as is the case in the energy and
carbon markets in liberalised systems. Uncertainty
translates into risk insofar as the economic impact
of uncertain events can be calculated. Risk management is a basic economic activity. From the perspective of market participants there are risks that can be
hedged against within the existing market framework
and others that cannot be hedged against (e.g. future
changes to market rules) or only at prohibitively high
cost.
For conventional technologies, uncertainties and
risks related to wholesale market prices are of key
importance. The stochastic nature of scarcity events
23 Worldbank and Ecofys (2018)
is arguably the most critical source of investment
risk.
The fact that scarcity events are stochastic (occurring occasionally when demand is high and feed-in
from v-RES is low) implies that the total cost of an
investment in conventional capacity may not be fully
recovered during the operational lifetime of the plant,
if the number of actual scarcity events (and price
spikes) is smaller than expected.
The risk of partial cost recovery becomes higher the
lower the expected number of operational hours is.
(Peaking plants are a typical case.) Once an investment decision has been taken, several years can pass
until it goes operational, and market conditions may
change in the meantime. As a result, investors in
mid-merit and peaking plants apply “top-ups” – i.e.
risk premiums – to their investment assessment valuation as a hedge against lower wholesale prices and
diminished capacity. Accordingly, funding costs rise
as uncertainty increases.
Fuel price developments and the evolution of future
ETS certificate prices constitute another source of
risk, yet they are already an intrinsic part of the
power price risk, because fossil-fuel power plants
typically set prices in the wholesale market and the
operators of conventional plants can thus employ
risk management activities (such as buying primary
energy derivatives and forward contracts for CO₂
allowances and selling derivatives of forward contracts for electricity).
Though hedging instruments (futures, forwards,
options) are available for reducing market risks, they
cannot fully alleviate all uncertainty. For example, the
available long-term markets for hedging are typically incomplete.24 Accordingly, a simple theoretical
24 Market completeness is the extent to which the full set
of forward and spot markets and risk management tools
are available for each product. Incomplete markets do not
maximize efficiency (Stiglitz, 2001).
19
Agora Energiewende | A Star for China’s Energy Transition
energy-only market cannot always ensure sufficient
capacity, as market risk cannot be optimally allocated among market participants. Less than optimal
capacities cause high prices, increasing the likelihood
of overshooting investment – this is known as boom
and bust cycles – and cannot fully facilitate a shift to
a more flexible and less-carbon intense power mix.
Uncertainty with regard to future price levels and
scarcity price situations are also affected by a broader
set of political and regulatory risks. Political risks
may take many forms. One risk is the implementation
of price caps to protect consumers from excessively
high and volatile prices, and to mitigate the market
power of key actors. Another is that investors cannot anticipate future market design adjustments that
affect price distribution. Similarly, the active removal
of inflexible, baseload capacity affects investment in
efficient and flexible technologies.
market incentivises new investments and delivers
system reliability, many politicians and regulators
seem to doubt the effectiveness of the energy-only
market. In practice, declining reserve margins in the
power systems have triggered debates about the need
to incentivise additional investments to “keep the
lights on”, be it full-blown capacity markets or “safety
net approaches” such as capacity reserves or strategic reserves.25 The introduction of such instruments
and the public discussion surrounding them have
increased uncertainty among market participants,
making market-based investments in new capacity
less likely.
Realistically, therefore, the question is not whether
interventions that increase system reliability can be
avoided but how to make sure that they are economically feasible with a power system with high-level of
variable renewables.
Capital intensive technologies like solar PV and wind
are more vulnerable to risk and uncertainty than
investment in fossil-fuel fired capacity, and thus more
likely to suffer from high risk-premiums when market
conditions are the same. High-capital cost technologies depend on stable revenue streams from selling
electricity on the market. Even small increases in the
risk premiums of RES projects may increase capital
costs and thus lead to a significant rise in project costs.
The important point here is that other, less capital-intensive investments are much less exposed in their
cost and financing structure to risk. This puts RES
projects at a major competitive disadvantage when
compared with conventional generation technologies.
The situation in China is a good example. There, “supply security” is not just a constraint on system operation; it is also the ultimate goal, more important than
economic efficiency itself.
Regulatory risk: Politicians do not want to take responsibility for the risk of outages by implementing
safety nets
25 Capacity reserves, also known or strategic reserves, address the political concern that the EOM might not build
sufficient capacities. They do not reduce risks for the remaining capacities inside the EOM. Hence, they may create
a “slippery slope effect”, where the size of the reserves
becomes larger and larger due to the lack of market-driven
investment.
A reliable and secure power system is important for
any economy, and power system reliability is often
considered a public good. Even if an energy-only
20
Cost of renewables: the market value of renewable energy tends to decline as the share of renewable
power in the mix rises
There is an ongoing and important academic debate
concerning the electricity market prices achieved
by RES installations during the hours they produce
when the power system has a high share of vRES.26
26 See, for instance, Agora Energiewende (2015), Hirth (2013)
and Hartner et al. (2015).
IMPULSE | A Star for China’s Energy Transition
There is some evidence that a higher share of vRES is
associated with falling market revenues for each kWh
of vRES electricity produced. Some questions remain,
however. For instance, does the reduction in market revenue decline slower or faster than the LCOE of
newly built RES capacity? Do more flexibility options
in the power system result in a bottoming out of the
market price? Does the market value of wind and PV
decline as a function of the speed of their deployment? Does their market value increase relative to the
speed by which the overall power system becomes
more flexible?
If the market revenues from wind and PV were to fall
faster than LCOEs, this would support the argument
that wholesale market revenues from wind and PV
cannot fully recoup investment in these technologies
when their share is high.
Furthermore, when the share of RES is high, the marginal price in the wholesale market is set by RES and
nuclear, not by fossil fuel-fired plants regulated by
the ETS. During these hours, the ETS does not add to
the market price obtained by RES producers. As soon
as the last fossil-fired power plant ceases its dispatching, the market price could drop to the marginal cost of nuclear and/or the marginal cost of RES
installations – i.e. zero for wind and PV.27 In a system
with a large share of renewables, RES investors would
anticipate such developments and not invest in new
RES capacities unless there were some mechanism
for generating stable market revenues, even in presence of large shares of zero-carbon capacity.
Again, the general theory of the EOM does not
address the financing challenge that occurs when
there is a high share of zero-marginal-cost capacity in the market. It also fails to reconcile the key role
played by wholesale power markets with the political
imperative of creating a zero-carbon power system
within two decades.
27 It depends on whether the supply side or the demand side
sets the price.
1.3 Additional Complexity in the
Chinese System
China has begun discussions about the best regime
for its power market, along with a process of reform
launched in 201528. Like their counterparts in the EU
and USA, scholars and practitioners in China have
talked about the value of economic theory and how
to apply it in practice. Two China-specific elements
further complicate this debate: the specific Chinese
dispatch regime, and the overcapacity of coal-fired
power plants. Seeing how many studies already shed
light on the second aspect,29 we have decided to focus
on the dispatch paradigm.
While these factors have profound economic, policy
and political implications, China has the opportunity to leapfrog some of the difficult learning phases
experienced by the EU and the USA and to develop
a coherent and effective power market regime right
from the beginning.
The conventional dispatch paradigm is inflexible and
conflicts with the nature of vRES
The dispatch principle in the current Chinese power
system is not merit-order based, and thus not cost
effective. Its system is characterized by horizontally
split baseload preferences, low granularity scheduling, and plan-based transmission volumes as the
boundary for provincial balances. Such a dispatch
model strongly conflicts with the nature of variable renewable energy that requires an increasingly
flexible power system. Figure 6 illustrates this relation: the more variable renewables are added to the
system, the less baseload and mid-merit electricity is
needed. Such changes are not reflected in the Chinese
28 On the review on the current progress, see Davidson et al.
(2017), Pollitt (2018), and RAP (2018).
29 See, for instance, Kahrl et al (2011) and Jiang et al. (2018)
21
Agora Energiewende | A Star for China’s Energy Transition
The dispatch paradigm conﬂicting with the profile of (residual) load curve with high level renewable
Figure 6
Variable
renewables
[ Pd ]
Load [ GW ]
Low capacity credit
Dispatchable
plants
Reduced full-load
hours
Hours of one year (sorted)
Overproduction
[ time ]
0
Load duration curve
Demand
Intermediate load
Residual load duration curve
Peak load
Intermediate load
Note: Renewables would reduce the residual load duration until the base load disappears; coarse-scale scheduling (right) still prevails
in China’s power system operation.
Personal communication with Professor Chen Haoyong, Sept. 2017; Ueckerdt et al. (2013)
dispatch pattern, which leads to inefficiency and
increasing costs.
The shortcomings of the current Chinese system
include:
1. The annual generation plan guarantees minimum
full-load hours for coal-fired power plants (production quota) in every province.
2. Due to technological and institutional limitations,
thermal power plants are unable to vary their output. (See Figure 7 for an example of system operation in a typical day.) Minimum output is usually
set at 50 per cent of technical capacity.30
3. Finally, CHP plants are usually heat led and often
not equipped with the technical parameters to
decouple heat and power output. As they have a
30 Davidson et al. (2017). By comparison, German and Danish
coal-fired power plants are operated flexibly and can reduce their minimum load up to 10 per cent of gross capacity. See Agora Energiewende (2017b).
22
social obligation to satisfy heat demand in winter, CHP plants must adhere to increased minimum
heat production. This takes priority over downward regulation in order to accommodate wind or
solar power. This market framework is not conducive for developing alternative heat generation
or storage, which might alleviate the problem. In
the regions heavily relying on CHP (e.g. Northeast
China), the minimum load is normally as high as
60 per cent or more, which leaves little room for
other options.
4. Transmission lines across provinces and regions
are operated in a very inflexible manner. This limits the “smoothing effect” of the variability of wind
and solar plants that the grid infrastructure can
provide.
Changing from “average dispatch” to “economic dispatch” is inevitable as the growth of variable renewable energy fundamentally challenges the current
regime. The absence of price information (e.g. when
power plants do not submit bid data at each time
IMPULSE | A Star for China’s Energy Transition
Typical operation in the power system of China
Figure 7
Wind
Load + planned export
Hydro
Thermal
Nuclear
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
Luo Zhiqiang (2017). Power market in SGCC: review and outlook. Presentation at the 9th Clean Energy Ministerial (CEM9),
Copenhagen, Denmark, May 2018.
scale) and the coarse scale of balance scheduling leads
to low system operation granularity.
Furthermore, larger dispatch areas, which would
benefit the whole system, are simply not practical
in the current regime. The top (centralised) dispatch
operators are superior to provincial level operators
and usually stick to planned transmission schedules, regardless of variable electricity production and
residual load.
A recent study confirms the positive effects of an
economic dispatch regime: the reduction of curtailment and the number of coal plant operating hours
and significant social cost savings such as lower rates
for consumers and less air pollution.31 But the study
31 According to Wei (2018), coal consumption would be
reduced by six per cent.
also found that changes in the dispatch regime would
bring about strong redistributional effects. Inefficient
coal power plants would go out of business, leading to
job losses and affecting local and regional economies.
A further challenge is the growing overcapacity of
coal-fired generation, which has intensified since
the addition of 50 GW of new coal capacity in 2015.
Another 200 GW are currently under construction or
planned. In 2017, coal still contributed 60 per cent to
the capacity mix and over 70 per cent to the generation mix despite the booming development of renewable energy. If the current trend continues, China
would largely have a coal capacity of 1,100 GW or
more by 2020 (Figure 8).
Because demand is not growing at the same pace as
capacity, the projected share of coal power in 2020
significantly overshoots the economical optimum.
23
Agora Energiewende | A Star for China’s Energy Transition
Baseload coal power units built within the past 15 years dominate the power system in China
400
Figure 8
15
350
14
300
[ GW ]
250
12
200
11
150
10
100
9
50
8
0
Before
1990
< 300 MW
1990–
2000
2001–
2005
2006–
2010
[ 300, 600 ] MW
Own compilation based on official data from NEA and CEC (2011).
In a competitive market, operational hours would
decrease significantly, shrinking revenues accordingly. It is easy to imagine that the owners of coal
plants are not the most enthusiastic proponents of the
economic dispatch model. Local governments, whose
coal assets tend to be smaller and less efficient, are
particularly afraid of such a change.
24
> 600 MW
2011–
2016
Under
construction
Planned
Average age (right axes)
[ Average age ]
13
IMPULSE | A Star for China’s Energy Transition
2.
Five Golden Rules for the Chinese
Power Market Transition
China aims to achieve a 50 per cent share of non fossil-fuel based electricity in its power mix by 2030.
This is an ambitious goal, but doable. First and foremost, it requires a stringent and coordinated package of policies. To this end, we have identified Five
Golden Rules for future power system design. Following these rules will help to fulfil expansion targets
while also keeping reliability high and costs low:
These five golden rules apply to the power market and
its interaction with other energy sectors. An energy
transition in the wider sense obviously requires
attention to other aspects as well – including in particular grid design and energy efficiency – but these
issues are addressed in other publications.
→→ 1. U
se existing generation capacity efficiently by
implementing short-term markets
→→ 2. Incentivise flexibility to ensure system reliability and adequacy
→→ 3. Provide stable revenues for new investment in
renewables
→→ 4. Manage the decline of coal and its structural
consequences
→→ 5. Acknowledge the pivotal role of transparency
and data accessibility
The China Star: five rules for renewable integration and new investment in China.
Figure 9
Provide
stable
revenue for
renewable
energy
Transparency
and data
accessibility
Use
existing
assets
efficiently
Manage
decline of
coal
Ensure
system
reliability
Own illustration
25
Agora Energiewende | A Star for China’s Energy Transition
Golden Rule 1 | Use Existing Generation
Capacity Efficiently By Implementing
Short-Term Markets
Since the power sector was liberalised in the 1990s,
short-term markets have become common place in
Europe and parts of the US. The main tenet of the
short-term market is the merit order principle. The
merit order is a way of ranking available sources of
electricity generation capacity, based on ascending
price (reflecting the short-run marginal costs of production) together with the amount of energy that will
be generated. Provided there is no distortion, generation units with the lowest marginal costs are the first
ones to be brought online to meet demand, and the
plants with the highest marginal costs are the last to
start operating.
In the rest of the world, merit-order based dispatch
was common practice even before liberalisation of
the power section took place. This is fundamentally
rooted in the fact that merit-order is a cost-minimised system.32 Merit-order dispatch leads to various
effects that are relevant to the present discussion.
One is a merit-order effect by renewables. Here, the
integration of renewable generation on the wholesale market right-shifts the merit-order generation
curve, which noticeably reduces the clearing price
32 Neoclassical economics says that an efficient market
follows three distinct theoretical principles when pooling
resources: a marginal pricing principle; an opportunity cost
pricing principle; a no-arbitrage principle. Pricing based
on merit-order aligns with these principles. See details at
CNREC (2017).
Short-term marginal cost [ USD/MWh ]
Illustration on how merit-order based dispatch ensure short term efficiency
Figure 10
Range of demand
PPeak
Price at high demand
Price at low demand
Poff-peak
Coal
lar
d, so
, win
o
r
d
Hy
lear
Nuc
Coal
rbine
rbine
as tu
as tu
g
g
le
le
c
yc
n-cy
ed-c
Ope
Clos
Installed capacity [ GW ]
Adapted from CNREC (2017)
26
Oil
IMPULSE | A Star for China’s Energy Transition
while slightly increasing the amount of traded energy
(which is an almost inelastic demand curve). This has
strong implications for the funding of renewables
discussed under Golden Rule 3.
Another effect is the huge price fluctuations due to
variation in demand and output (Figure 10) by the
second, minute, hour, day, season and year. Take German price data as an example. The range of electricity
prices is 1000 per cent of the mean electricity price,
and prices varied by a factor of at least two during a
normal day. The price of other energy carriers fluctuated much less: natural gas prices varied by 70 per
cent of the mean price and crude oil prices by 36 per
cent of their mean. Neither commodity demonstrated
within-day price variation.33 Chinese government
and society have been working to accommodate massive price variations like these.
China has tested short-term markets in some areas
already. The aim is to have them fully operational in
eight provinces by early 2019. Based on the above
principles, our recommendations are as follows for
the Chinese context:
→→ Make trading and system operations as open and
transparent as possible. A well-functioning market should be open to all actors and follow a set of
well-defined, non-discriminatory rules. Issues of
generator size should not prevent market participation; anyone capable of providing services (such
as flexibility) should be able to participate. In this
context, access to data is often key. It is therefore
recommended that the market pilots establish a
data hub that is open to all market participants and
the public.
→→ Establish pilot trading systems that allow trading with short-interval electricity products and
shorter lead-times (e.g. hourly settlement with
day-ahead lead times) and strengthen capabilities for relevant hardware and software development. The coarse scale of the preceding system
33 Hirth et al. (2013)
is no longer valid. Automated technology allows
us to trade close to real time, and shorten the time
intervals to less than an hourly scale. This is very
positive, because hourly or even quarter-hourly
products better reflect variations in demand and
renewable energy production.
→→ Strictly adhere to China’s renewable energy law
and compensate renewable asset owners for curtailed energy. The curtailment of renewable energy
is strongly driven by the available grid infrastructure and therefore occurs in market-based systems
as well as in non-market-based systems. Renewable energy generators have not yet received payments for the curtailed hours. This has a detrimental effect on cost (it is energy already paid for) and
climate (it would have been carbon-free energy).
Moreover, it is a strong disincentive for companies
to invest in new renewable assets. A consistent
merit-order approach would shift the risk of curtailment to those market participants who produce
when costs are higher and demand is lower.34
→→ Gradually expand system operation and actual
balancing areas from individual provinces to
larger regions. In the current dispatch paradigm,
the balance area is restricted to individual provinces, with local demand and long-distance trading separated into two different markets. Coupling
regional markets would allow a better deployment
of existing resources for balancing and therefore
lower costs. But the establishment of a single national short-term market is a medium- to longterm project. A gradual coupling of provincial or
regional spot markets will nevertheless create positive effects, and should eventually lead to a uniform national market.
34 See RAP (2015b), Hove and Mo (2017) and Dupuy and Wang
(2016).
27
Agora Energiewende | A Star for China’s Energy Transition
Golden Rule 2 | Incentivise Flexibility to
Ensure System Reliability and Adequacy
The greatest concern for policy makers and system operators is keeping electricity systems secure,
which means preventing black-outs and brown-outs.
System security has two aspects: system reliability,
i.e. the short-term ability of the system to balance
demand and supply; and system adequacy, i.e. the
long-term ability of generation assets to cover peak
load.
Amid growing shares of renewable energy, power
systems are changing. Power is no longer produced
only by centralised stations; the increasing number of variable sources such as solar and wind has
led to more distributed production. The power system thus needs to coordinate a fast-growing number of actors, while the volatile nature of renewable
sources requires systemic changes in technology. In
short, flexibility must become the new paradigm of
power markets. Flexible services can be delivered by
both supply and demand sides. The most important
flexibility options are: grid design, dispatchable firm
capacity (fossil and non-fossil), demand response,
storage, and the interaction of the electricity system
with other sectors (such as transport and heating &
cooling).
Safeguarding system adequacy and system reliability
has become a dynamic issue: it is not only about “how
much” capacity is needed but also about “what kind”
of capacity. When it comes to short-term system
reliability, markets are usually considered the best
way to satisfy needs. Experience from Europe and the
US shows that flexible services can be incentivised in
every market segment, although long-term forward
markets usually do not fall into this category. Figure
11 illustrates the process.
When it comes to long-term system adequacy, the
situation becomes more complicated. In fact, there is
an ongoing argument amongst experts as to whether
energy-only markets are able to incentivise optimal
investment in new generation capacity. Theoretically,
this might be possible. But the predictions of theory
are not always reliable.35
At this point, we are not ready to argue for one side
or the other. But it remains a fact that many policymakers have opted for an additional instrument
to safeguard system adequacy – namely, capacity
remuneration mechanisms (CRMs). We can roughly
distinguish three different variations of CRMs:
35 For a short overview of this discussion, see Agora Energiewende (2013).
Sequence of market-based transactions in a typical deregulated power system
Figure 11
“Flexibility markets”
Central coordination by TSOs
Forward
markets
Day-ahead
market
Intraday
market
Balancing
market
Energy markets for decentral transactions
Years to weeks
before delivery
12 AM: Day-ahead auction
for each hour of next day
Trading of 60-/15-minute products
“Gate closure”
till 30 min. before delivery
30 min. before delivery
* Imbalance penalties incentivise market actors to obey physically to their market trades
CE Delft and Microeconomix (2016).
28
Real-time delivery
for 15 min. intervals*
IMPULSE | A Star for China’s Energy Transition
→→ Strategic reserves, as used in the Scandinavian
market36
→→ CRMs outside the energy market in some American markets, e.g. capacity auctions in PJM, NYISO
and MISO37
→→ CRMs within the energy market, e.g. Operating Reserve Demand Curve (ORDC) in the Texas ERCOT
market38
Whatever instrument is chosen, its design is crucial in order to deliver the needed additional flexible
resources and limit distortions to the energy-only
market. Therefore, the instrument should reflect the
difference in value between resources with different
capabilities. Efficient energy and balancing markets
remunerate flexible technologies more than inflexible ones. The same can be said of capacity/capability
remuneration instruments.
ence from Germany and Denmark could provide
important insights here.39
→→ Change the “benchmark tariff system” for coalfired power plants. This is an important step for
disincentivising coal assets.40 Currently the price
mechanism does not differentiate between capacity payments and energy revenues.41 Instead,
power plants enjoy the generous “benchmark price”
set by the government.42
→→ If China, as has been proposed, adopts a capacity
remuneration mechanism (CRM), it is crucial that it
be designed in such a way that it
(a) does not severely distort future energy-only
markets, and
(b) rewards flexibility, e.g. ramping capacity,
instead of baseload capacity.
The question of how to incentivise flexibility
resources is becoming ever more important in China.
Our recommendations are as follows:
→→ Establish a short-term market, as discussed in
Golden Rule 1. This would be the best way to incentivise flexibility on the supply side, and – if
designed well – on the demand side as well. As the
development of such a functioning short-term
market takes time, we recommend that interim
steps be taken (see below). It is important that these
interim mechanisms are reversible and compatible
with short-term markets in the long run.
→→ Make existing coal-plants more flexible to save
costs, reduce emissions and provide more flexibility in the power system. From a technical point of
view, most Chinese coal plants would need retrofits
to be operated in a load-following mode. Experi-
39 See Agora (2017b).
40 See Hu (2016); RAP (2016).
36 See http://ec.europa.eu/competition/sectors/energy/strategic_reserve_en.pdf
37 See Sprees et al. (2013).
38 See www.ercot.com/content/wcm/training_courses/107/
ordc_workshop.pdf
41 It should be noted that the system is evolving. In 2017, bilateral trading counted for roughly 20 per cent of the total
electricity market.
42 The benchmark price is indexed to the coal price and
therefore differs across provinces. For details, see Jiao et al.
(2010).
29
Agora Energiewende | A Star for China’s Energy Transition
Golden Rule 3 | Provide Stable Revenues
for New Investments in Renewables
reality often looks different. Nevertheless, FIT levels
were sufficiently attractive for investors to create a
veritable renewables boom in China in recent years.
The rapid decline in vRES generation costs constitutes an ongoing trend worldwide, not least of all
in China. The latest auction for solar PV projects in
Baicheng, Jilin, cleared at around 5 euro cents, close to
the local benchmark price of coal-fired generation.43
This development is in line with the expectations of
the Chinese government, which anticipates cost parity between wind/solar PV and coal by 2020.
The renewables surcharge on consumers has reached
1.9 RMB cents/kWh, or 3 per cent of the end-use tariff. This amount is considered the politically acceptable maximum. Because the government does not
plan to exceed this limit,44 it has started to search for
alternative mechanisms with lower direct costs. In
May 2018, the Chinese government abruptly cut subsidies for solar PV, resulting in 20 GW less installed
capacity than previously envisaged. The government
also issued a guideline document that requires auction-based pricing for post-2018 utility-level wind
and solar projects.45 However, it has yet to make the
details of the transition from FIT to auctions public.
Roughly ten years ago, China adopted a Feed-in Tariff
(FIT) to support wind energy; soon after, it introduced
one for solar PV. The system established a reference
price for the regulated benchmark price of coal power,
but it does not give priority access for renewable
energy in the grid. Therefore, curtailment of wind
and solar energy is high. Although the renewables
law calls for the compensation of curtailed energy, the
44 This information is based on informal sources in the NEA.
45 See NEA (2018b).
43 See https://m.jiemian.com/article/1976259.html
The costs of renewables and their market value with and without carbon pricing
120
35
[ EUR/MWh ]
25
Profile effect/
“cannibalisation“
Revenue
gap
20
15
60
20
5
0
0
2025
2025
Wholesale price
30
Revenue
gap
80
40
10
Redl (2018)
Profile effect/
“cannibalisation“
100
[ EUR/MWh ]
30
Figure 12
Market revenue
LCOE
IMPULSE | A Star for China’s Energy Transition
With technology costs for wind and solar reaching
competitive prices with coal, more and more people
are calling for a halt to any kind of financial support
for renewable energy. Typically, they argue that wind
and solar should be able to compete with other generation sources, especially when wholesale power markets are in place. They believe that support should be
phased out once the emissions trading scheme pilot
projects are introduced throughout all of China.
These claims are built on false assumptions about the
nature of renewable technologies. Even if distorting
effects like full-load hour guarantees for coal plants are
dismantled (which has yet to occur in China), renewable energy would be unable to recoup its investment in
a competitive market. This is due to the specific market
value of zero-marginal cost technologies. The better the
conditions for wind and solar, the more electricity they
produce, driving down the price. Thus, at times when
wind and solar produce a lot of electricity, they hardly
earn money, because prices are low. At the same time,
when they are not producing, prices are high, but they
cannot take advantage of this revenue opportunity.
This so-called cannibalisation effect (solar and wind
cannibalise their own market value) becomes increasingly relevant as the share of wind and solar capacity
grows and more and more hours of low or even zero
prices occur. This may sound like a future issue for
China, but it is in fact a huge concern now for investors
who need to calculate their revenues for periods of up
to 25 years. Figure 12 illustrates this dilemma.
→→ The renewable obligation policy now under consideration in China should respect the principle of
a unified power market. When designing market mechanisms, such as renewable obligations (as
well, carbon ETS markets), policy-makers should
avoid creating separate markets that distort, rather
than strengthen, the price signals of the united
electricity market. By mixing the “green power”
and “green certificate” in current design, and a separate market for cross-regional power transmission, China risks bifurcating power markets and
distorting price signals.
→→ The auction design should reflect risk alleviation
concerns. The lower the risks, the lower the cost
of capital, the lower the costs for new renewable installations. Ensuring low investor risks is an
efficient way to further expand renewables while
driving costs down.
To provide certainty for investors in renewable
energy, therefore, a long-term mechanism needs to be
in place that ensures constant and fair revenue flows.
Our recommendations for China in the short term are
as follows:
→→ Fully implement and enforce the renewable energy
law, especially the principles of priority grid access
and priority dispatch. The law constitutes the logical foundation for the compensation of renewable
curtailment.
31
Agora Energiewende | A Star for China’s Energy Transition
Golden Rule 4 | Manage the Decline of
Coal and Its Structural Consequences
In the Chinese energy mix, coal is king. China is the
world’s largest producer, consumer and importer of
coal. By 2017, coal accounted for about 60 per cent of
China’s energy consumption and around 65 per cent
of its electricity consumption. However, this situation is changing:
→→ Due to improved efficiency, use is declining and
economic activities are changing 46
→→ Coal resources in some regions are depleted
→→ Air pollution from coal emissions is a growing concern
→→ Signs of climate change are becoming more and
more obvious
Having acknowledged these factors, the Chinese government is now seeking to manage the transformation
of the power sector. In the 11th Five-Year Plan (2005–
2010), the central government began to force provinces to close over 80 GW of small and inefficient coal
plants, leading to social disruptions in many regions.
Furthermore, it launched a programme to replace small
and old plants with new and larger ones.47
More recently, China has started testing an emissions
trading scheme in certain pilot regions. According
to observers, it will take at least a decade until China
concludes these pilot programmes. It remains to be
seen whether China will be able to avoid the traps of
other emissions trading schemes such as the over-allocation of certificates. We believe it would be a great
mistake to try to cut carbon use using an emissions trading scheme alone. Instead, it seems wise to
implement additional instruments that help actively
manage the decline of the current coal fleet.
The smart management of the coal fleet phase-out
will enhance the overall efficiency of the transition
46 Spencer et al. (2018).
47 Zhang and Qin (2016).
32
towards a clean energy system while mitigating its
negative consequences on workers and regions. Our
recommendations are therefore as follows:
→→ Immediately ban new coal: Overcapacity is already
an issue today. Adding more coal capacity – with
an envisaged lifetime of 40 to 50 years – will severely aggravate the situation. The risk of stranded
assets is high, and the costs will be borne by the
workforce and to a certain extent by society as a
whole. An immediate cessation of coal plant construction is thus a first and important step.
→→ Fully exploit the potential of the emissions trading
scheme: Though there are serious doubts that the
ETS will suffice, it is important to make it as effective a tool as possible. Learning from the mistakes
in Europe is a good idea. This means acknowledging the interdependencies between ETS and other
policy instruments. The cap in the ETS should not
be fixed; rather, it should be a function of the outcomes of other instruments such as feed-in tariffs,
energy efficiency measures and smart retirement
instruments. Thus, any CO₂ reductions that go beyond their projected baseline must be deducted in
order to preserve the cap’s economic efficiency and
environmental integrity.
→→ Supplement the ETS with additional instruments
that actively retire existing coal-fired power
plants, as we have seen it in other parts of the
world. In principle, the following options exist: a)
an emissions performance standard that requires
power plants to keep emissions below a certain
threshold, b) a fiscal instrument such as a tax on
carbon or c) a distinct phase-out plan that determines the life-time of every single coal unit, as is
currently being discussed in Germany.
→→ Anticipate socio-economic impacts on affected
regions and facilitate structural change. As a managed decline of coal will lead to changes in social
and economic systems of regions that rely on coal
today, it is crucial to consider an active management of the structural changes in these vulnerable regions; especially with regards to the financial
implications.
IMPULSE | A Star for China’s Energy Transition
Golden Rule 5 | Acknowledge the
Pivotal Role of Transparency and Data
Accessibility
The Chinese power system is transitioning from a
highly regulated system to more market-based one.
The government is committed to the use of market
forces in the allocation of resources, though it will
continue to employ regulatory instruments as well.
Whatever system emerges, the transformation process will take time and will require policy makers to
devote attention to numerous processes occurring in
parallel. Many tasks still lie ahead in practically every
area: improving infrastructure, designing efficient
market-based mechanisms, and managing the social
effects of the transition, to name but a few.
Luckily, nowadays, digital technologies allow for the
easy and cost-effective collection, treatment and
publication of relevant data. Weather forecasts, for
instance, have improved significantly and allow us
to project electricity generation of wind and solar
installations. Transmission lines can be observed
with digital devices, allowing system operators to
detect congestion or even break-downs in just seconds. Likewise, system operators can track production and consumption at a very granular scale in real
time, even in a large country like China. Making all
this (and other) data accessible to market participants
will promote the smooth operation of the market
while also contributing to the efficiency and reliability of the power system.
Our recommendations are therefore as follows:
An area that needs special attention is the availability and transparency of data. A power system that
is increasingly based on thousands and millions of
small, medium-size and large-scale generation units,
and that involves growing numbers of market participants on the supply and demand sides, requires intelligent steering mechanisms. A centralised authority
is no longer capable of acting as an “all-powerful operator” to manage such a system. Rather, the
information conveyed by prices within the scope of a
market system is essential. China’s decision to implement a spot-market is, therefore, the right one.
But a market can deliver adequate results only when
market participants have access to information.
Investors need ample information to make decisions
on future investment, be it in generation, grids or
flexible services. Similarly, consumers need information to make deliberate decisions and negotiate with
suppliers. And system operators need information on
plant availability, on weather conditions, and on grid
congestion. The same is true for generators, who need
this kind of information to ramp up or ramp down
a specific unit or to take it offline entirely. If transparency is lacking, markets tend to develop informal
structures dominated by certain players who abuse
their market power.
→→ Require system operators to publish data and allow
public access. Such public reporting requirements
need explicit guidelines that stipulate report formats, frequency, time resolution, etc.48
→→ Initiate impact assessments and public debates,
which can prevent negative and distortive effects
with regards to market unification and policy efficiency.
→→ Promote the visualization of data and strengthen
the development of software and other related tools
in China through, say, R&D subsidies. This will ease
access and data interpretation by market participants, prevent misinterpretations and improve use
of data and system efficiency.
48 The EU Transparency Regulation N °543/2013 could provide interesting insights regarding the granularity of such
a regulation.
33
Agora Energiewende | A Star for China’s Energy Transition
34
IMPULSE | A Star for China’s Energy Transition
Conclusions
China’s power system has initiated a transition
towards a renewables-based, market-oriented system. Much has been achieved already, and many
reforms have been launched. The government has
started to liberalise retail markets and distribution
grids for new owners and market players; short-term
wholesale markets are scheduled to start operating as
pilot projects soon; emissions trading schemes have
been established in several provinces; and the government is working on a new, auction-based renewable remuneration scheme. Much work remains to be
done, however.
In light of the sector’s dynamism – including in particular the rapid growth of wind and solar energy –
China must stay committed to reform efforts. The
strong growth in renewables witnessed in recent
years has encouraged the Chinese government to
adopt a more ambitious target for 2030. Instead of
the implied 38 per cent share of renewable electricity set forth by the NDC, the government now aims
to achieve 50 per cent share of non fossil-fuel based
electricity by 2030. Assuming realistic growth in
other technologies – including nuclear and hydro in
particular – we estimate that wind and solar energy
will need to account for around 25 percentage points
of the 2030 target.
To achieve these targets in a cost-effective way,
reforms to the power system must not be halfhearted.
The risk is that renewables curtailment, market distortions and other inadequacies will significantly
increase the costs for the Chinese consumer. It is
important to consider various policy instruments and
sectoral markets in a coherent manner, to take into
account their interdependencies and short-comings
and to develop a pragmatic and consistent set of policies that will eventually ensure a cost-effective, clean
and reliable power system.
The China Star: five rules for renewable integration and new investment in China.
Figure 13
Provide
stable
revenue for
renewable
energy
Transparency
and data
accessibility
Use
existing
assets
efficiently
Manage
decline of
coal
Ensure
system
reliability
Own illustration
35
Agora Energiewende | A Star for China’s Energy Transition
To these ends, we have proposed Five Golden Rules
for reforming the Chinese power market. These five
golden rules are:
→→ Golden Rule 1: Use existing generation capacity
efficiently by implementing short-term markets
→→ Golden Rule 2: Incentivise flexibility to ensure
system reliability and adequacy
→→ Golden Rule 3: Provide stable revenues for new
investment in renewables
→→ Golden Rule 4: Manage the decline of coal and its
structural consequences
→→ Golden Rule 5: Acknowledge the pivotal role of
transparency and data accessibility
These five aspects are interconnected and need to
be addressed holistically. If China keeps them all in
mind, it will have a chance to leapfrog to a power
market design that accommodates very high shares
of renewables –while also keeping costs down and
ensuring system reliability.
36
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IMPULSE | A Star for China’s Energy Transition
41
Publications by Agora Energiewende
IN ENGLISH
A Word on Low Cost Renewables
The R
­ enewables Breakthrough: How to Secure Low Cost Renewables
A Word on Flexibility
The German Energiewende in practice: how the electricity market manages fl
­ exibility challenges when the
shares of wind and PV are high
Report on the Polish power system 2018
Version 2.0
The Future Cost of Electricity-Based Synthetic Fuels
Energiewende 2030: The Big Picture
Megatrends, Targets, Strategies and a 10-Point Agenda for the Second Phase of Germany’s Energy Transition
A Future for Lusatia
A Structural Change Plan for the Lusatia Coal-Mining Region
The European Power Sector in 2017
State of Affairs and Review of Current ­Developments
FAQ EEG – Energiewende: What do the new laws mean?
Ten questions and answers about EEG 2017, the Electricity Market Act, and the Digitisation Act
Reducing the cost of financing renewables in Europe
A proposal for an EU Renewable Energy Cost Reduction Facility (“RES-CRF”)
Refining Short-Term Electricity Markets to Enhance Flexibility
Stocktaking as well as Options for Reform in the Pentalateral Energy Forum Region
A Pragmatic Power Market Design for Europe’s Energy Transition
The Power Market Pentagon
Eleven Principles for a Consensus on Coal
Concept for a stepwise decarbonisation of the German power sector (Short Version)
Energy Transition in the Power Sector in China: State of Affairs in 2016
Review on the Developments in 2016 and an Outlook
42
Publications by Agora Energiewende
IN CHINESE
Flexibility in Thermal Power Plants (Chinese translation)
With a focus on existing coal-fired power plants
Eleven Principles for a Consensus on Coal (Chinese translation)
Concept for a stepwise decarbonisation of the German power sector
IN GERMAN
65 Prozent Erneuerbare bis 2030 und ein schrittweiser Kohleausstieg
Auswirkungen der Vorgaben des Koalitionsvertrags auf Strompreise, CO2-Emissionen und Stromhandel
Die Kosten von unterlassenem Klimaschutz für den Bundeshaushalt
Die Klimaschutzverpflichtungen Deutschlands bei Verkehr, Gebäuden und Landwirtschaft nach der EUEffort-Sharing-Entscheidung und der EU-Climate-Action-Verordnung
Vom Wasserbett zur Badewanne
Die Auswirkungen der EU-Emissionshandelsreform 2018 auf CO₂-Preis, Kohleausstieg und den Ausbau der
Erneuerbaren
Strom­netze für 65 Prozent ­Erneuerbare bis 2030
Zwölf Maßnahmen für den synchronen Ausbau von Netzen und Erneuerbaren Energien
Die zukünftigen Kosten strombasierter synthetischer Brennstoffe
Energiewende 2030: The Big Picture
Megatrends, Ziele, Strategien und eine 10-Punkte-Agenda für die zweite Phase der Energiewende
Die deutsche Braunkohlenwirtschaft
Historische Entwicklungen, Ressourcen, Technik, wirtschaftliche Strukturen und Umweltauswirkungen
All publications are available on our website: www.agora-energiewende.de
43
144/06-I-2018/EN
About Agora Energiewende
Agora Energiewende develops scientifically
based and politically feasible approaches for
ensuring the success of the Energiewende.
We see ourselves as a think-tank and
policy laboratory, centered around dialogue
with energy policy stakeholders. Together
with participants from public policy, civil
society, business and academia, we
develop a common understanding of the
Energiewende, its challenges and courses
of action. This we accomplish with a
maximum of scientific expertise, oriented
towards goals and solutions, and devoid of
any ideological agenda.
This publication is available for
download under this QR code.
Agora Energiewende
Anna-Louisa-Karsch-Straße 2 | 10178 Berlin | Germany
P +49 (0)30 700 14 35-000
F +49 (0)30 700 14 35-129
www.agora-energiewende.de
info@agora-energiewende.de
Agora Energiewende is a joint initiative of the Mercator Foundation and the European Climate Foundation. The
cooperation of Agora Energiewende and the China National Renewable Energy Centre in China is kindly supported
by the Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) on behalf of the German government.

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